According to District Judge Francisco A. Besosa of San Juan, the automatic stay in PROMESA, the federal law to alleviate Puerto Rico’s financial crisis, does not bar holders of general obligation bonds from suing to enjoin the commonwealth from allowing proceeds of the island’s sales and use taxes to be paid to holders of so-called COFINA bonds that are secured by liens on those income streams.
The Supreme Court decided in June that Puerto Rico’s instrumentalities are ineligible for municipal debt adjustment under chapter 9 of the Bankruptcy Code and that the island commonwealth is precluded from adopting local laws to ameliorate the insolvencies of its unit. Within days, the President signed the Puerto Rico Oversight, Management, and Economic Stability Act, commonly known as PROMESA. The law contains a broad automatic stay modeled after Section 362 of the Bankruptcy Code.
Pursuant to an executive order the governor of Puerto Rico signed immediately after the adoption of PROMESA, the commonwealth defaulted on $817 million in general obligation bonds but continued to pay COFINA bonds with revenue from sales and use taxes.
Holders of general obligation bonds sued in Judge Besosa’s court in July under PROMESA, characterizing the obligations owing to them as “constitutional debt” backed by the island’s full faith, credit and taxing power. Citing provisions in Puerto Rico’s Constitution, they contend that their debt must be paid first, taking precedence over COFINA bonds.
In their suit, the general obligation bondholders seek a declaration and injunction preventing Puerto Rico from using sales and use taxes to pay COFINA bonds, even though COFINA bondholders have liens.
In Judge Besosa’s court, Puerto Rico and the COFINA bondholders filed motions alleging that the suit by the general obligation bondholders was automatically enjoined by Section 405 of PROMESA. Concluding that the suit was not automatically stayed, Judge Besosa ruled against Puerto Rico in his Feb. 17 opinion.
PROMESA’s broadly worded automatic stay, on cursory analysis, would seem to halt the suit by the general obligation bondholders on the theory that they are attempting to recover on a claim against the government or to obtain possession of property. Although Judge Besosa said that PROMESA’s and Section 362’s automatic stays are “nearly identical,” he allowed the suit to proceed.
Since the general obligation bondholders were seeking to enforce Section 303(3) of PROMESA, which prohibits an executive order modifying the rights of debtholders, Judge Besosa said there was no automatic stay violation because the suit was asserting a claim that could not have existed before PROMESA.
Because the general obligation bondholders were seeking only a declaration and injunction, not payment, Judge Besosa said there no was attempt to collect on a claim and thus no violation of the automatic stay.
Similarly, the bondholders were not attempting to take possession of property because an injunction would only “preclude the Commonwealth from dissipating its assets in a manner that violates PROMESA.”
Judge Besosa also declined to characterize the suit as attempting to enforce a lien because an injunction would only prevent Puerto Rico from spending money and transferring assets in a manner that violates PROMESA.
The decision recognizes the practical necessity for deciding the dispute between the general obligation and COFINA bondholders. Assuming Puerto Rico initiates a court-supervised debt arrangement, the workout will conclude sooner because Judge Besosa has allowed the litigation to proceed.
The general obligation bondholders conceded that other claims in their complaint were subject to the automatic stay, so Judge Besosa did not deal with them.